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Three considerations for SPAC readiness and SOX compliance

Authors

  • Ronald Wong

    EY Asean and Singapore Financial Accounting Advisory Services Leader; Partner, Assurance, Ernst & Young LLP

  • Adele Liew

    Financial Accounting Advisory Services Partner, Ernst & Young LLP

7 minute read 18 May 2022
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SPAC target companies need to comprehensively address three key areas of material weakness to pave the way for listing success.

In brief

  • Companies considering a SPAC merger should start their SOX readiness preparation as early as possible.
  • People, process and policy are three key areas of material weakness that SPAC target companies should address.
  • A robust process to regularly test controls and perform remediation should be established so that there is a low risk of material weakness.

Companies seeking to ride the special purpose acquisition company (SPAC) wave must be prepared to address financial reporting and governance issues arising from the SPAC merger. A SPAC merger generally moves much faster than a traditional IPO, with the pressure intensifying when the SPAC approaches the end of its 18- to 24-month lifecycle. Target companies should therefore have a comprehensive plan to address the demands of becoming a public company on an accelerated timeline.

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The US SEC has highlighted internal controls as one of the unique risks of a private company entering the public markets through a SPAC merger. Entities should therefore focus on their internal controls to comply with Sarbanes-Oxley Act (SOX) requirements. To achieve this, an entity must understand and revisit its internal control over financial reporting (ICFR) program as well as disclosure controls and procedures on a timely basis.

 

As implementing SOX requires proper planning and execution, it is time-consuming. And this may get complicated by acquisitions, group transformation and restructurings executed during the IPO journey. Entities that started on SOX from the ground up may therefore take at least a year or more to become fully compliant. Entities considering a SPAC merger should embark on their SOX readiness preparation as early as possible through process walk-throughs, processes and key controls documentation, internal control gap assessment, control gaps remediation and detailed control testing.

 

Material weakness arises when there are multiple control deficiencies in the entity’s ICFR, resulting in a reasonable possibility that a material misstatement in the company’s annual or interim financial statements will not be prevented or detected on a timely basis. SPAC target companies should prioritize addressing three key areas of material weakness: people, process and policy.

People

Common challenges faced by entities with material weaknesses include the lack of financial reporting and accounting personnel with relevant US GAAP, SEC reporting and internal control knowledge. The talent pool outside the US with SEC reporting knowledge is generally more limited. This limitation has several implications: It hampers the entity’s ability to address complex technical accounting issues in a timely manner as well as the preparation and review of consolidated financial-statements-related disclosures in accordance with GAAP and financial-reporting requirements or interpretations set forth by the SEC. This results in a risk of increased SEC comments and the company’s inability to appropriately respond to the comments. And in more extreme cases, it may result in restatements of previously reported financial statements.

In addition to the requisite technical accounting knowledge, it is also important for organizations to have adequate personnel with a deep knowledge of internal controls. A lack of such talent may risk the proper setup of the internal control framework, which can lead to control design and operational failures.

With the proper internal control framework and controls in place, it is important to train people and build a strong culture of internal controls around the organization. Non-compliance with controls around things such as the company’s policies and code of conduct will lead to operating control deficiencies.

To address the people-related issues, entities should consider onboarding sufficient accounting staff who are knowledgeable in GAAP or IFRS (as applicable) and SEC reporting requirements early in the SPAC journey. Supplementing this with proper training of existing finance personnel and building internal controls around financial reporting will set a strong foundation to manage the strict reporting requirements and timelines as a listed company.

Beyond the requisite technical accounting knowledge, organizations also need sufficient
personnel with a deep knowledge of internal controls to help avoid control design and
operational failures.

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Process

Digital adoption, transformation and the growing complexity of businesses operating globally create technical accounting challenges. They also drive an increase in internal controls and an emphasis on the reliance on system access and change as well as operational controls. Gaps may arise where there is a lack of formal group-wide risk assessments to identify, assess, address and mitigate risks to maintain effective internal controls within the organization. Material weaknesses will increase the risk of error, fraud, misstatement of financial reporting and non-compliance with related regulations for a US-listed group.

 

To resolve these issues, entities with deficient internal controls should start by conducting a review of existing processes and internal controls to identify key gaps and control design deficiencies. Companies can consider engaging consultants and professional accounting services firms to augment in-house technical accounting expertise to help assess and document the internal controls for SOX compliance.

 

After analyzing the weaknesses, entities should design and implement controls that address risks associated with significant classes of transactions. Striking a balance between key manual controls and system controls is critical for a risk-based approach to address risks over financial reporting. And this must be reassessed on a regular basis so that controls evolve with the business.

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Policy

Common control deficiencies in policies include a lack of comprehensive accounting policies and procedures based on GAAP or other applicable accounting standards as well as a lack of documentation to support key accounting positions. The lack of comprehensive accounting policies and procedures manuals to facilitate the preparation of financial statements impacts subsidiaries’ ability to prepare a robust reconciliation from local books to group GAAP for consolidation.

 

To address this, entities should establish a comprehensive accounting policies and procedures manual focusing on areas where there are significant judgments and estimates. Training should be provided to all key accounting staff for consistency in the application of documented policies and procedures. In addition, having a technical accounting and financial reporting team to monitor and update the policies as the business and transactions evolve is important to sustain compliance. 

 

As target entities work toward SPAC readiness, they should ask themselves the following questions: 

  • Have we thought about our future finance operating model, including talent and skill sets to support effective internal controls over financial reporting?
  • Has our company properly scoped the key processes and related controls and found the right mix of controls?
  • Are our selected key controls precise enough to detect significant issues over financial reporting?
  • Are we regularly updating our ICFR program to be able to respond to changes in the business and regulatory requirements?
  • Do we have a proper evaluation process to support our SOX Sections 302 and 906 certifications?
  • Is there a proper process in place to regularly test controls and perform remediation so that there is a low risk of material weakness?
  • Have we leveraged technology and other tools to manage internal controls more effectively?

Summary

Private companies seeking to go public through a SPAC merger should focus on their internal controls to comply with SOX requirements. As they work toward SPAC readiness, SPAC target companies need to prioritize addressing three key areas of material weakness: people, process and policy. They also need to consider issues such as the future finance operating model and the use of technology and other tools to manage internal controls more effectively.

About this article

Authors

  • Ronald Wong
    EY Asean and Singapore Financial Accounting Advisory Services Leader; Partner, Assurance, Ernst & Young LLP
  • Adele Liew
    Financial Accounting Advisory Services Partner, Ernst & Young LLP
Related topics
IPO
Private business
Growth
Entrepreneurship
CFO agenda

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